Of late, the news has been abuzz with reports of numerous cases of corporate fraud. This involves cases of deliberate deception or misrepresentation, including in accounting and bookkeeping. The Securities and Exchange Board of India (SEBI) has started a series of crackdowns to identify the companies that have committed frauds. It has been investigating several cases, including listed companies cooking their books, making unsubstantiated claims about their finances, manipulating stock prices, and so on.
Corporate frauds and impact on stakeholders
Frauds have a ripple effect on the economy at large. Corporate frauds, in particular, have a widespread impact because of the huge number of stakeholders involved - customers, investors, Regulators, Banks, and lenders. This is why many corporate frauds eventually end up being banking/financial frauds;
Studies indicate the number of banking frauds in India increased significantly in FY21-22. When it comes to the financial services sector, India has been losing a staggering `100 crore every day over the last seven years to frauds. We can take some comfort in the fact that the total y-o-y figure has been reducing over the years, but is that enough? There is a tendency for fraudulent corporates to blame external factors for bank defaults, but regulators and the government need to differentiate between business failures and frauds.
If a bank has been involved in perpetrating the fraud, then at the very least, it is at risk of its reputation being tarnished. Not to mention the hefty monetary losses it faces in terms of higher provisions, NPAs, and loss of customers. For end customers of the bank, this may even lead to higher interest rates due to the higher credit costs. As banks struggle, the economy suffers and so do the investors.
How are regulatory authorities placed on the issue?
The Securities and Exchange Board of India (SEBI) has taken various actions in the face of rising corporate fraud. It has taken steps to identify, mitigate or prevent fraud by getting involved during the different stages of the fraud. It has also published several directives to address any systemic abuse. For example, SEBI’s corporate governance guidelines include directives on appointing independent directors on boards and submitting annual reports of audited accounts, besides frequent crackdowns on rule breakers. More recently, it has amended regulations to strongly link corporate fraud in listed companies to securities fraud - a powerful move. These are in addition to the regulation on end-use of funds, credit monitoring, etc by the Reserve Bank of India.
Opt for prevention over cure
One of the tried-and-tested ways by which corporates can keep malpractice at bay is to ensure there are robust governance mechanisms in place. Corporate governance is a system that is designed to ensure that the company is, simply put, well-managed. It includes the board of directors, independent directors, and committees, like the audit or ESG committees, which are responsible for overseeing the operations of the company and making sure that they comply with legal and regulatory requirements.
Corporate governance ensures that the company is operating in a way that benefits all stakeholders, not just the majority shareholders. Besides strategic oversight, the system identifies potential risks or early warning signs and takes timely steps to mitigate them.
Heeding the signs/ signals
What are some of the indicative early warning signals leading up to fraud detection?
Early warning signals can help corporate lenders by detecting prospective fraud and alerting them in advance. For example, the following may be early indicators of fraud or fund misappropriation:
- Suspicious use of company resources, such as the opening of shell companies
- Unusual patterns or irregular spikes in money movement such as circular transactions among accounts held by group companies
- The excessive inventory is not proportionate to sales
- Frequent errors and inconsistencies in payments and invoicing
If early warning signs are tracked on time, companies can identify potentially fraudulent transactions before they happen, like identifying a request for a money transfer to a party that’s not among the usual raw material suppliers to the company. They can also detect patterns of fraud regardless of the scope and scale, like fund siphoning over some time by inflating prices on invoices.
Technology-enabled fraud monitoring systems available in the market today combine sophisticated technologies, like AI/ML, NLP, and big data, to identify patterns based on current and historic data and alert authorities before the damage is done. Fraudsters often rely on the fact that most organizations do not have robust or integrated fraud management strategies in place. Early warning signals can help detect these threats before they escalate into serious problems.
However, fraud prevention is not a one-time process. It requires constant monitoring and updating of the system to keep up with changes in the environment. Fraud monitoring systems should be able to identify anomalies in real-time and provide insights on how fraud could happen. A culture of continuous improvement that integrates the corporate machinery with technology and ensures across-the-board stakeholder involvement is integral to this.
(The author is CEO of BCT Digital)